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MercadoLibre's Quarter Was Far Better Than It Looked

A change in accounting rules and postal rates combined to make this quarter's results look horrible. But there's more here than meets the eye.

Going into MercadoLibre's (NASDAQ:MELI) first-quarter financial report, there was a lot of uncertainty. Last quarter, the company deconsolidated the results of its Venezuelan subsidiary from its financial statements, because of rampant hyperinflation in the country and Venezuela's recent default on its bonds.

The company also announced a change to its capital allocation policy, suspending its dividend in favor of investing in the business. MercadoLibre has been ramping up its free or reduced-cost shipping to better compete, as Amazon.com gears up for a meaningful push into the region.

A change to U.S. accounting standards and a significant increase in Brazilian postal rates impacted MercadoLibre's financial results, making them even more complicated, as investors worked to understand the new normal.

For the just completed first quarter, MercadoLibre reported net revenue that grew to $321 million, up 19% year over year in U.S. dollars and 30% in local currency. This was significantly below analysts' consensus estimates for revenue of $413.96 million.

However, adjusting for the new accounting standard would have added $112.5 million, producing revenue of $433.5 million, up 60% year over year and significantly above expectations.

The company reported a net loss of $12.9 million, and a loss per share of $0.29, far worse than the $0.44 in earnings per share expected by analysts. This was primarily the result of postal rate changes, outlined below.

Operational metrics

Metric

Q1 2018

Q1 2017

Year-Over-Year Change

Confirmed registered users

223.1 million

182.2 million

22%

Items sold

80.1 million

53.2 million

50%

Payment transactions

74.3 million

44.1 million

68%

Data source: MercadoLibre Q1 2018 financial release.

MercadoLibre's operational metrics continued to shine, though the growth moderated somewhat in the seasonally slow first quarter.

Those pesky accounting changes

The previously referenced accounting change (ASC 606 for us accounting nerds) requires that the cost of MercadoLibre's free shipping initiatives be deducted from the net revenue number, where it was previously presented as a cost of sale. The result is growth rates that appear lower. In the case of the current quarter, the shipping costs of $112.5 million were 26% of the company's total revenue.

Brazil went postal

Accounting change aside, the situation that had the greatest impact on the company's results was a massive increase by Brazil's national postal service Correios. Shipping fees for local and state deliveries increased by 8% or more, while packages on national routes saw increases of 30% to 50%. This increase in shipping charges in MercadoLibre's largest market was enough to generate a loss during the quarter.

From an operational metrics standpoint, this had the biggest impact on small items that aren't eligible for free shipping subsidies, resulting in a slightly slower growth rate in items sold.

A legal challenge is pending in the Brazilian courts regarding the increases, and MercadoLibre has escalated the process for onboarding a host of competing delivery services. The increase in delivery costs has also provided an incentive for merchants to adopt Fulfillment by MercadoLibre, which colocates merchant inventory at the company's fulfillment centers, reducing overall shipping expenses.

A look ahead

CFO Pedro Arnt commented: "We are as excited as we have ever been about growing our businesses. We will continue to drive the success of our company through building on our market position as a leading innovator in Latin America, and leveraging our regional breadth, trusted brand, and increasing installed base of engaged users."

MercadoLibre accelerated its efforts to add multiple delivery options, which will minimize the impact of the postal increases. The company expects the issue to be short-lived, and to return to profitability in due course.

Author

Daniel W. Vena, CPA, CGMA is long-term investor searching for intangibles that provide explosive growth opportunities in his investments. He served on active duty with the US Army and has a Bachelors degree in accounting.
Follow @dannyvena